Chapter 3 – Applicability of Accounting Standards

Chapter 3 – Applicability of Accounting Standards

 

Key Concepts and Overview of Applicability of Accounting Standards

1. Applicability of Accounting Standards (AS)

Accounting standards in India are issued by the Institute of Chartered Accountants of India (ICAI). They are mandatory for companies, firms, and other entities that prepare financial statements, depending on the size, nature, and structure of the entity. The Accounting Standards (AS) are divided into Mandatory Standards and Non-Mandatory Guidelines.

2. Applicability for Various Entities

The application of accounting standards depends on the type of entity, its size, and its legal requirements.

a. Applicability to Companies

  • For companies governed under the Companies Act, 2013, accounting standards are mandatory. These companies must comply with the applicable Accounting Standards (AS), which are specified by the Ministry of Corporate Affairs (MCA).
  • Large companies listed on stock exchanges or having large public interest must follow Ind AS (Indian Accounting Standards), which are aligned with IFRS (International Financial Reporting Standards).
  • Small and medium-sized companies are required to follow AS, which are less complex than Ind AS.

Case Study:

Background: XYZ Ltd., a listed company, is required to follow Ind AS as per the guidelines issued by MCA due to its size and listing status.

  • XYZ Ltd. must prepare its financial statements in compliance with Ind AS 115 (Revenue from Contracts with Customers) and Ind AS 16 (Property, Plant and Equipment).

b. Applicability to Non-Companies (Other Entities)

Non-companies, such as partnership firms, LLPs (Limited Liability Partnerships), sole proprietorships, and non-corporate entities, are not bound by the same legal framework as companies. However, some of them are still required to follow accounting standards as per the Accounting Standards for SMEs (Small and Medium Enterprises).

  • Partnerships and LLPs: These entities are generally required to follow the Accounting Standards for Small and Medium-sized Entities (SMEs).
  • Sole Proprietorships: In many cases, accounting standards are optional for sole proprietorships unless the proprietor wishes to present financial statements that are more formal and comparable.

Case Study:

Background: ABC LLP is a small partnership firm in the business of retail. The firm needs to prepare financial statements for its tax filings and business transparency.

  • ABC LLP may be eligible to apply AS 1 (Disclosure of Accounting Policies), AS 9 (Revenue Recognition), and other relevant standards but may not be required to comply with the full suite of Ind AS as they are a small entity.

c. Applicability Based on Turnover/Net Worth

  • Mandatory Application for Certain Thresholds: The applicability of AS or Ind AS also depends on the turnover and net worth of the company or entity.
    • For Companies: The Ministry of Corporate Affairs (MCA) mandates Ind AS for companies meeting specific thresholds related to:
      • Net worth exceeding ₹250 crores
      • Turnover exceeding ₹500 crores
    • For Small and Medium Enterprises (SMEs): These companies follow AS instead of Ind AS unless they exceed these thresholds.

Case Study:

Background: DEF Ltd., a medium-sized manufacturing company, has a net worth of ₹300 crores and a turnover of ₹600 crores.

  • DEF Ltd. must prepare its financial statements under Ind AS because it exceeds the threshold of ₹250 crores in net worth and ₹500 crores in turnover as per MCA guidelines.

3. Transition from AS to Ind AS

For companies transitioning from the Accounting Standards (AS) to Ind AS, it is important to understand that Ind AS is more aligned with IFRS (International Financial Reporting Standards). This transition typically applies to larger companies, listed companies, or those with international operations.

Key Points in Transition:

  • Ind AS replaces AS for companies that meet the criteria mentioned above.
  • The transition may involve changes in how certain transactions are accounted for, such as revenue recognition, lease accounting, and financial instruments.
  • Companies may also need to adjust their comparative financial statements and apply Ind AS on a retrospective basis.

Case Study:

Background: GHI Ltd., a listed company, has a turnover of ₹700 crores and meets the net worth criteria. The company is transitioning from AS to Ind AS for the first time.

  • GHI Ltd. needs to apply Ind AS 101 (First-time Adoption of Indian Accounting Standards), which will provide guidance on how to prepare its first set of financial statements under Ind AS, including how to handle any adjustments required for the transition.

4. Applicability of AS for Specific Types of Transactions

a. Business Combinations (Mergers and Acquisitions)

  • AS 14 deals with business combinations, including mergers, acquisitions, and amalgamations. It mandates specific disclosures and treatment for goodwill, assets, liabilities, and the acquisition method.
  • Ind AS 103 applies to larger companies in the case of business combinations, offering more detailed rules on fair value measurement and goodwill.

Case Study:

Background: JKL Ltd., a medium-sized company, acquires a smaller competitor, PQR Ltd. The transaction is structured as an amalgamation.

  • JKL Ltd. must follow AS 14 for accounting the amalgamation under the pooling of interest method or purchase method (depending on the structure of the deal).

b. Lease Accounting

  • AS 19 outlines the accounting for leases, including classification and disclosures. However, for companies transitioning to Ind AS, Ind AS 116 (Leases) replaces AS 19, which significantly changes the accounting for leases by lessees.

Case Study:

Background: MNO Ltd., a company transitioning to Ind AS, enters into a lease agreement for office space.

  • Under Ind AS 116, MNO Ltd. will recognize both the right-of-use asset and the lease liability on its balance sheet, which differs from the treatment under AS 19, where leases were classified as operating or finance leases.

5. Specific Exceptions and Exemptions

Certain entities are exempt from following specific accounting standards based on their size, structure, or nature. These include:

  • Small and Medium-sized Companies: These entities may have exemptions for specific standards or simplified disclosure requirements.
  • Non-Profit Organizations: Such organizations often have different requirements, especially in how they report donations, grants, and assets.

Case Study:

Background: LMN Charitable Trust, a non-profit organization, prepares financial statements for its donors and regulatory filings.

  • The Trust may follow AS 6 (Depreciation Accounting) and AS 12 (Government Grants) but will have fewer requirements for disclosures related to operating segments or revenue from sales as compared to a corporate entity.

Conclusion

Chapter 3 on the Applicability of Accounting Standards (AS) in CA Intermediate provides a crucial understanding of which entities must comply with the accounting standards and how they apply based on entity size, structure, and the nature of the transactions. Whether the company is large and required to follow Ind AS or smaller and only required to comply with AS, understanding the applicability ensures that students can appropriately apply accounting standards in real-life scenarios. The case studies and examples provide practical insights into how these standards are implemented in different organizational contexts.

By mastering this chapter, students will be able to determine the correct accounting treatment and disclosure requirements for various types of businesses and entities, ensuring compliance with the applicable accounting framework.

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